Morningstar DBRS Downgrades Credit Ratings on Two Classes of A10 Permanent Asset Financing 2015-I, LLC

DBRS, Inc. (Morningstar DBRS) downgraded its credit ratings on the following classes of notes issued by A10 Permanent Asset Financing 2015-I, LLC:

-- Class B Notes to A (low) (sf) from A (high) (sf)
-- Class C Notes to B (high) (sf) from BB (sf)

Morningstar DBRS also confirmed its credit rating on the following class:

-- Class A at AAA (sf)

Morningstar DBRS maintains its Stable trend on Class A and Negative trends on Classes B and C.

The credit rating downgrades and Negative trends on Classes B and C reflect the increased credit risk to the transaction as a result of decreased projected recovery proceeds for the transaction’s one specially serviced loan and the negative outlook with regard to the concentration of loans secured by office collateral, which includes ten loans, representing 44.3% of the current pool balance as of the January 2024 reporting.

The specially serviced loan, Northwoods Crossing (Prospectus ID#23, 5.1% of the pool), is secured by an office property in Allentown, Pennsylvania. The loan transferred to special servicing in April 2022 because of imminent payment default after the property’s former largest tenant, United Concordia Companies, Incorporated, which previously occupied 89.4% of the net rentable area (NRA), vacated its space in May 2022. The loan has been delinquent since May 2022, and according to the servicer, the loan became real estate owned in December 2023. The property has a negative cash flow, with occupancy most recently reported at 4.7% as of the June 2023 rent roll. An updated appraisal completed in July 2023 valued the property at $5.1 million, down from $7.4 million in June 2022 and $21.1 million at issuance. There are $2.9 million in servicer advances outstanding, resulting in a current loan exposure of $14.8 million; however, the servicer does hold $3.4 million in cash reserves against the loan. In its analysis, Morningstar DBRS assumed a stressed value and liquidated the loan from the trust, resulting in a hypothetical loss severity on the loan in excess of 60%. The loss is projected to be contained to the unrated equity bond.

As of the January 2024 remittance, the pool consists of 37 loans with a cumulative trust balance of $232.8 million, representing collateral reduction of 22.2% since issuance. Since the previous Morningstar DBRS credit rating action in March 2023, the pool has paid down by $5.3 million as a result of scheduled loan amortization. As noted above, office properties represent the largest concentration by property type in the transaction, including three of the largest four loans, which collectively represent 28.3% of the current pool balance. All three loans are on the servicer’s watchlist and exhibit increased credit risk from closing as a result of sustained declines in occupancy and cash flow. More information on each loan can be found below; however, in its analysis of each loan, Morningstar DBRS made loan-to-value (LTV) and probability of default (PoD) adjustments, resulting in increased loan expected loss levels above the expected loss for the pool. The second-largest property type concentration in the transaction is retail, with 17 loans representing 39.8% of the current pool balance, followed by four multifamily properties, representing 8.5% of the current pool balance.

As of the January 2024 reporting, there are eight loans on the servicer’s watchlist, representing 41.4% of the current pool balance. The loans remain current and have generally been flagged for performance-related reasons, including low debt service coverage ratios (DSCRs) and low occupancy rates. The largest loan on the servicer’s watchlist and in the transaction, 610 West Ash (Prospectus ID#35, 13.5% of the pool), is secured by an office property in downtown San Diego, California. The loan is being monitored for occupancy concerns. The property’s largest tenant, ESET (37.0% of NRA), was initially expected to vacate upon its November 2023 lease expiration; however, the tenant executed a short-term renewal, extending its lease through August 2024. It appears the tenant gave back a portion of its space in conjunction with the renewal as occupancy decreased from 82.0% as of September 2023 to 72.9% as of YE2023. Given the short renewal, Morningstar DBRS notes the tenant may not be committed to the property beyond the August 2024 lease expiration. If ESET does ultimately vacate, the occupancy rate would decrease to 51.3% absent any other leasing activity. The loan will continue to operate under a cash flow sweep until either ESET executes a long-term lease or the space is re-tenanted. Backfilling the space will likely be challenging as market vacancy within the downtown submarket of San Diego has surpassed 20.0%, according to Q3 2023 Reis data. The servicer notes there is $333,000 in the excess cash reserve, $2.0 million in the rollover reserve, $645,000 in the capex reserve, and $208,000 in the tax reserve. According to the Q3 2023 financials, the property generated $3.2 million net cash flow (NCF), with a reported DSCR of 1.53 times (x); however, both figures are expected to decline moving forward as a result of increased vacancy. Given the occupancy decline combined with soft market fundamentals, Morningstar DBRS increased the PoD on the loan, resulting in an increased loan-expected loss approximately two times greater than the expected loss for the pool.

The second-largest loan on the servicer’s watchlist and in the transaction, View 8 (Prospectus ID#21, 8.8% of the pool), is secured by a Class A office property in Midvale, Utah. The loan is being monitored for occupancy concerns after tenant, ZAGG, gave back 26,333 square feet (sf) of space as part of its lease renewal in August 2022. The reduction in space decreased occupancy to 77.4%. The servicer confirmed the occupancy rate had risen slightly to 79.3% as of September 2023. The property generated annualized NCF of $1.9 million for the T-9 period ended September 30, 2023, with a reported DSCR of 1.31x. In its analysis, Morningstar DBRS applied a market cap rate to the in-place NCF, which resulted in an elevated LTV ratio, implying current market equity in the transaction may be significantly reduced from loan closing. In addition, Morningstar DBRS increased the PoD, resulting in an increased loan-expected loss of nearly two times greater than the expected loss for the pool.

The third-largest loan on the servicer’s watchlist, 205 W Wacker (Prospectus ID#5, 6.0% of the pool), is secured by a 23-story, Class B office building within the Loop submarket of downtown Chicago. Occupancy decreased to 60.5% when the property’s former largest tenant, Salesforce, Inc. (Salesforce; 8.4% of NRA), exercised an early termination option and vacated in September 2021. Since then, occupancy slightly rebounded to 67.7% at YE2023 as the borrower executed four new leases in 2023 totaling 9,548 sf, according to the servicer. The loan is under a cash flow sweep with a fixed monthly amount of $37,000 until the Reduced Performance Period is cured. As of the January 2024 remittance, the excess cash reserve has a balance of $341,200. Outside of tax and insurance reserves, the loan has a reserve balance of $3.6 million. According to the servicer, the property generated an annualized NCF of $2.9 million for the T-9 period ended September 30, 2023, with a reported DSCR of 1.22x. In its analysis, Morningstar DBRS applied a market cap rate to the in-place NCF, which resulted in an elevated LTV near 100.0%. In addition, Morningstar DBRS increased the PoD, resulting in an increased loan expected loss of approximately two times greater than the expected loss for the pool.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

All credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by Morningstar DBRS.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is North American CMBS Surveillance Methodology (March 16, 2023), https://dbrs.morningstar.com/research/410912.

Other methodologies referenced in this transaction are listed at the end of this press release.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS’ outlooks and credit ratings are under regular surveillance.

DBRS, Inc.
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The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

-- North American CMBS Multi-Borrower Rating Methodology (November 3, 2023)/North American CMBS Insight Model Version 1.2.0.0, https://dbrs.morningstar.com/research/422859
-- DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023), https://dbrs.morningstar.com/research/420982
-- North American Commercial Mortgage Servicer Rankings (August 23, 2023), https://dbrs.morningstar.com/research/419592
-- Interest Rate Stresses for U.S. Structured Finance Transactions (June 9, 2023), https://dbrs.morningstar.com/research/415687
-- Legal Criteria for U.S. Structured Finance (December 7, 2023), https://dbrs.morningstar.com/research/425081

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at [email protected].